Thursday, April 29, 2010

OK, maybe they landed a glove or two....

According to the Washington Post, "The Securities and Exchange Commission has referred its investigation of Goldman Sachs to the Justice Department for possible criminal prosecution, less than two weeks after filing a civil securities fraud case against the firm, according to a source familiar with the matter.

The Wall Street Journal and Bloomberg News reported Thursday night that the U.S. Attorney's Office in Manhattan had followed up on the request and opened a criminal probe. The office declined to comment.

It is very rare for the government to indict a firm, and the mere threat of criminal prosecution can destroy a company. A criminal investigation destroyed the infamous Wall Street firm Drexel Burnham Lambert in the 1980s even though the firm settled with authorities."

Tuesday, April 27, 2010

Never laid a glove on them

I attended part of Senator Carl Levin's Permanent Subcommittee on Investigations hearing concerning Goldman Sachs. Bottom line: they never laid a glove on them. As one report noted, "By day’s end, the investment bank’s market value had risen by $549 million." My comments follow.

1. When questioned about most matters, Goldman's CEO simply misdirected the questioner to an irrelevant portion of the inquiry. Specifically asked a direct question about the firm's short position (a position that benefits from a fall in prices, in this case, housing prices) in the mortgage market, the CEO referred to Goldman's 140 year history (this was a misdirection), and characterized the firm's position as a hedge (this was false). A key factor relates to relative position size. A $1 million dollar long position offset by a $1 million dollar short position is a hedge. A $1 million dollar long position offset by a $10 million dollar short position is a directional bet on the market, not a hedge.

2. In addition, Goldman's CEO purposely confused the market making role Goldman plays with their role as an underwriter. As a market maker, a size matched ($1 million long for $1 million short) hedge on a position is appropriate. This insures liquidity and an ability of the firm to respond to customer requests. As an underwriter, a bank is using it's reputation to sell product to clients. Underwriting carries with it a higher level of fiduciary duty. This is where misstatements about the construction of a security are critical. (Think of it this way. If you manufacture and sell cars, you have an implicit obligation to sell safe cars. I will not buy a car from you if I know that you, or a partner firm involved in the design and manufacture of the vehicle, have taken out a life insurance policy on me, the car buyer, and designed the car to maximize the chances that you, or a partner firm, will be able to collect on the insurance policy by reducing the reliability of the car's braking system. This is what the SEC says Goldman did.)

3. A question was asked about Goldman's use of the discount window at the Fed. The answer given by Goldman was not accurate. An accurate answer would have cited the total dollar amount of benefits the firm received from all Emergency Federal Reserve Liquidity Programs. These include the Term Auction Facility (TAF), the Primary Dealer Credit Facility (PDCF), the Term Securities Lending Facility (TSLF), the Term Securities Lending Facility Options Program (TOP), the Commercial Paper Funding Facility (CPFF), the Asset-Backed Commercial Paper (ABCP) Money Market Mutual Fund Liquidity Facility (AMLF), the Money Market Investor Funding Facility (MMIFF), as well as the currency swap arrangements with foreign central banks.

Friday, April 16, 2010

SEC accuses Goldman Sachs of civil fraud

According to the Washington Post, "The Securities and Exchange Commission filed charges Friday against Goldman Sachs, one of the most successful but vilified banks on Wall Street, for misleading and defrauding investors in selling a financial product based on subprime mortgages.

In filing the civil suit against Goldman Sachs, the agency is targeting one of the banks that largely escaped the wreckage of the financial crisis and, with the help of various forms of government aid, emerged stronger."

We believe this may be the first in a series of actions targeting Goldman. An examination of Goldman's transactions with AIG will probably reveal similar questionable practices. As we noted on July 9, 2009, the US lost 53% supporting Goldman.

As we noted on March 5, 2009, Goldman was one of several firms accused of systematically cheating customers.

And, finally, as noted on July 19, 2007,

"From an ethical standpoint, (Goldman) has repeatedly engaged in behavior that would cause a prudent person to question its objectivity and fairness. We note that a smaller firm engaging in similar conduct would have been severely sanctioned by the market. Goldman has escaped meaningful sanction, however. We have found these behaviors often the prelude to the development of a set of fraudulent business practices."

Our focus on evaluating of both financial and ethical practices at major firms, once again, seems prescient.